How to save the euro zone

April 10, 2012

By Kathleen Brooks. The opinions expressed are her own.

There’s a 250,000 pound prize for the best idea on how to break up the euro zone, but how much would you pay to see the euro zone saved?

There is no denying that the euro zone is in a mess right now, but there are some steps that could help ease the crisis. Essentially the markets hate to be 1) misled and 2) confused. The European authorities have consistently sent mixed messages and reneged on their promises. For example, they said there would be no haircut on Greek debt then when it became obvious Greece had to re-negotiate its massive debt pile the authorities said Greece would be the exception. Now the markets believe there is a good chance that Portugal will have to follow suit.

Thus, the first step to saving the euro zone in its current form is to sort out communication. If debts need to be re-structured in Portugal and Ireland then the European authorities should call an emergency meeting and come up with a broad set of parameters and rules for cutting these weak peripheral states’ debts. These could include; 1) a certain debt to GDP ratio that once surpassed mean that debts have to be re-negotiated; 2) A set percentage of debts to be renegotiated and no more than that; 3) Finally, a timetable for repaying the outstanding debts that is realistic. The debt repayment plan would be based on realistic growth assumptions then penalties could be applied if the schedule is missed.

The Fiscal Pact may be a new stage in the euro zone project, but in its current form it is only going to promote bickering, one-upmanship and the eventual disintegration of the currency bloc. The Fiscal Pact contains some good ideas, but the plan for budget deficits to return to no more than 3 percent of GDP by 2013 is too ambitious.

The euro zone has always been made up of diverse economies, so rather than creating one rule for all the authorities, it  would be better to have scaled fiscal targets. For example, for Spain they would need to take account of weak growth and an enormous unemployment rate to come up with a more realistic fiscal consolidation timetable. The markets are punishing the Spanish bond markets today for missed fiscal targets tomorrow. The markets aren’t reacting to the absolute levels of Spanish debt, instead markets tend to react negatively to missed expectations. Thus, one way to calm markets is to lower expectations and make the bar easier for Spain to get over.

This brings me to another point. Re-adjustment in the euro zone needs to take place, but it can’t happen overnight. It is a multi-year, maybe even decade-long process. Due to this it needs a safety cushion during the intervening period. The cushion could be a beefed up financial firewall to ensure that Spain, Italy etc. have a source of funds to tap if the markets get a bit jittery in the coming weeks and months. The only country who can provide this is Germany. It has the money (and the credit rating) to help beef up funds to the magic 1 trillion euro mark that could placate the markets as Europe’s periphery navigate their way through a harsh austerity era.

The final point is politics. Politics is poisoning the euro zone and could be its undoing. Elections in Greece and France could be game changers for the bloc this year, and could make the sovereign debt crisis a whole lot worse. Likewise, Angela Merkel is all too aware that she can’t spend her taxpayers’ euro too freely on bailing out fiscally irresponsible peripheral states as she has her own election to fight in 2013. Italy’s technocratic (read unelected) Prime Minister took aim at Spain the other week to push Madrid to tighten its fiscal targets. This behaviour will only promote rivalry and bitter disputes at just the time when the euro zone needs to pull together. We really need to see Europe’s leaders, even those who face elections in the next 18 months, to put their own interests aside and work on saving the euro zone, otherwise they will go down in history as the ones who let the currency bloc crumble under their watch.

These are just a few ideas and nowhere near as in depth as the entries to the Wolfson Prize for Economics on how to break-up the currency bloc. But if a few common sense ideas were employed by Brussels then the euro zone project stands a chance of staying in its current form. Without change, it is on the road to disaster.

Image — A man walks next to policemen outside an Eurobank branch in Athens March 21, 2012. REUTERS/John Kolesidis

Comments

There’s a 250,000 pound prize for the best idea on how to break up the euro zone, but how much would you pay to see the euro zone saved?

Errrrrrr…precisely nothing! Why would anyone pay to save a massive fraudulent, dictatorship?

Posted by mgb500 | Report as abusive
 

This entire column is reflective of what ails Europe– all platitude and no substance. There is NOTHING here that hasn’t been said a thousand times before. Why even print it?

Posted by washu | Report as abusive
 

Yawn. There already are debt to GDP ratio limits which France breached in 1997.

The only single way to solve the Eurozome crisis is to break up the Euro currency, and carry on with a free trade agreement and freedom of movement for citizens within the former European Union borders. The citizens of Europe have consistently voted against any further power for the EU but have been ignored by the head in the sand fools in Brusssels.

Any tinkering with ridiculous fiscal pacts will not achieve anything, other than an increase in the total debt owed by the citizens of Europe, which has been handed to them by the quarter-wit self interested and unelected European officials who keep throwing trillions more good money after bad.

Simply unwind the Euro at the same fixed exchange rates that it was created with, and then each country can print however much money they need to keep paying their debts.

Posted by JenkinsComp | Report as abusive
 

Yet another way for governments to be incentivised towards good financial controls is to have bonds that have variable coupons. The coupons would be a function of debt/gdp ratio and deficit (% gdp). So the higher the deficit, the higher the coupon. Granted it can accelerate the deficit, but there is a strong incentive to control government spending.

Posted by aleph0 | Report as abusive
 

A couple of observations –
1. A trillion euro bail-out fund will be like a massive bluff in a poker game – its very existence is meant to ensure that it will never have to be used (“seen” in poker terms). If it has to be used, and and I believe it will, the consequences for the eurozone will be disastrous, among other things, due to the inevitable political backlash in Germany.
2. The Greek economy, and several others in the eurozone, will never keep up with the German economy, and much, if not all, of the austerity, will be soaked up just to stand still. Is it really worth all that pain just to stay a member of what is perceived to be an elite club, when even major industrial nations such as the UK are clearly better off outside it, and on all sides of the political spectrum, there appears to be a universal sense of relief that we never joined it?

Posted by CO2-Exhaler | Report as abusive
 

Ms. Brooks, if we lower expectations, won’t investors go somewhere else to invest their money? Sure, the people who are all ready vested in these countries right now might tend to stay, but why would a new investor want to send money into Greece or Spain…..or many other Eurozone countries if expectations for growth and payment on debt is lowered. People put their money where they expect the greatest return on investment, and sending good money after bad will be pursued by very few people.

Posted by Timster84 | Report as abusive
 
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